At a coffee shop in Bluffton, South Carolina, people have been spontaneously paying forfuture customers’ drinks on a fairly consistent basis. Sometimes, those who are not even looking to buy coffee for themselves will come in and donate money for future (anonymous) customers.

While certainly unique, this may not be too surprising when viewed under the lens of behavioral economics — and could suggest an interesting business model. Let’s consider a hypothetical coffee shop that chooses to employ a strictly “pay-what-you-want-for-other-customers” pricing strategy, in which customers can only leave money to be used by other customers, and are allowed to leave as much (or as little) as they would like. In turn, their drinks are paid for by previous donations.

First, there are a number of examples in the scientific literature (and in the real-world) of the benefits of pay-what-you-want pricing systems. Allowing people to pay the price they want can sometimes result in people paying more money than they would if a standard price was requested for any particular product or service.

Second, recent research by Elizabeth Dunn, Lara Aknin, and Mike Norton shows that spending money on others can have a more positive impact on one’s happiness than spending money on oneself. So this may mean return visits by customers who wish to get that extra boost in happiness that they do not get from places where they buy their own selected product(s).

Third, Dan Ariely has studied how powerful the idea of “free” can be; in short, people love free things. Receiving a “free” drink in our hypothetical coffee shop (paid for by another customer) should be more desirable than directly paying for the drink.

At this hypothetical coffee shop with a “pay-what-you-want-for-other-customers” pricing strategy, customers may have an experience in which they get to enjoy a “free” product (good for that customer), get a boost of happiness from buying something for others (good for that customer…and the customer(s) who get to spend that money), and may wind up spending more money overall than they would have under a traditional pricing scheme (good for the coffee shop). Thus, allowing people to pay what they want for other customers may potentially lead to a lot of good all around.

There are certainly many risks that come along with a “pay-what-you-want-for-other-customers” pricing system. But if the events of the coffee shop in South Carolina are any indication, such a pricing strategy may just be irrational enough to work.

~Jared Wolfe~

I’ve explored the power of free in the context of tattoos before, and anyone who saw last years’ comedy Bridesmaids no doubt laughed at this particularly memorable scene. But this story out of the Netherlands caught me a little off guard just the same. First, consider what you would do for a year’s worth of free movie tickets. Or if you like live music, tickets to your favorite venue. Would you pay $200? Would you eat a bag of (nonpoisonous) insects?

Well, the Unlimited Movies Cinema in the Netherlands has offered moviegoers the opportunity to see free movies for an entire year—all they have to do is get the theater’s logo (a dog-like creature flying under a banner of unfurled film reel) tattooed on their body (for pictures, check this page out). The offer is part of a promotion for the latest movie in The Girl with the Dragon Tattoo series.

I developed an appreciation for the surprising power of FREE! from the experiments my colleagues and I conducted on how people respond to things when their cost is zero (included in Predictably Irrational). For instance, when we set up a temporary candy stand and sold mouthwatering Lindt truffles (which usually cost around 50 cents) for 15 cents and ho-hum Hershey Kisses for 1 cent, 73% of the chocolate-lovers who stopped by made the rational decision and chose the superior and highly discounted Lindt truffles. But when we lowered the price by 1 cent for each item—resulting in a cost of 14 cents and 0 cents respectively—suddenly demand reversed and 69% of consumers chose the free Kisses.

The power zero exercises over people’s choice in chocolate nicely demonstrates the irrational draw of free things, but it’s still difficult to know what to make of people getting a cinema logo (and not the most aesthetically pleasing one at that) permanently inked on their body for a single year of free movies.  While according to the story, only 18 people have elected to exchange skin space for free movies, one has to ask whether the wonders of free will ever cease…

When it comes to sterilization, Denmark has had a rather turbulent history. In 1929, in the midst of rising social concerns regarding an increase in sex crimes and general “degeneracy,” the Danish government passed legislation bordering on eugenics, requiring sterilization in some men and women. Between 1929 and 1967, while the legislation was active, approximately 11,000 people were sterilized – roughly half of them against their will.

Then, the policy was changed so that sterilization was still available, still free, but not involuntary. And as you might expect, the sterilization rate in Denmark dropped down dramatically – and stayed this way until 2010.

Now we come to 2010. In only a few short months, the sterilization rate increased fivefold. No, this was not a regression to the old legislation; it was a result of free choice…

What happened?  Last year, the Danish government announced that sterilization, which had been free, would cost at least 7,000 kroner (~$1,300) for men and 13,000 kroner (~$2,500) for women as of January 1^st, 2011. Following the announcement, doctors performing sterilizations found that their patient load suddenly surged. People were scrambling to get sterilized while it was still free.

Now, it could be that the people who were already planning on getting sterilized at some point in the future just made their appointments a bit sooner, and conveniently saved some money.  But I can also imagine that (much like our research on free tattoos) there were many people who did not really think much about sterilization before the price change, but were so averse to giving up such a good deal that it pushed them to take the offer and undergo a fairly serious procedure.

And although we usually don’t think about sterilization as an impulse purchase, it might just become one when a free deal is about to be snipped.

In many past experiments we have shown that people are often overly excited about things that are FREE (see Predictably Irrational).  An interesting opportunity to further look at this behavior presented itself when a few weeks ago a nightclub in New York City promoted an event with “free tattoos,” and we just had to check it out to see if the offer would tempt people to get one…

A large open room in an old industrial building with three wooden picnic tables lined up end to end in the center of the room. The tattoo station was a small portable table, two folding chairs and a cheap floor lamp.  Our research assistant, with her clipboard, was by far the cleanest and most official looking person around.  And when she offered to help the tattoo artist by taking the names of the people in line, he was delighted. In the 5 hours she was there (from 9pm to 2am) a total of 76 people signed up for free tattoos.

Who are these people?

The line for free tattooed was composed of the same number of males and females. The age range was 18 (underage for the event) to 47, with an average of 26.  As they were deciding to stand in line for the free tattoo we asked the participants how drunk they were at that point, and the average level of reported drunkenness was surprisingly low at 2.64 on a scale from 1-11 (however, it was later discovered that a better question to ask may have been “How intoxicated, drunk or high do you feel right now?”).

What were they getting?

Overall, the tattoos people wanted were very creative. Some notables were the phrase “Holy Snacks” on the inside bottom lip; one 27-year-old male wanted a Nintendo controller tattooed onto his left ribs; there was a request for a penis tattoo, and a few people wanted some version of infinity in English or in Swahili (Umilele).  Another notable groups were the 4 individuals that did not know what they wanted, but knew that they wanted some free tattoo, and 5 individuals that did not know where they wanted it.

Was it the FREE?

When we asked the people in line for the free tattoos if they would get the tattoo if it were not free, 68% said they would not.  They were only getting it because it was free.   We also asked the participants if they knew that there were free tattoos being offered at the party.  The 90% that knew they would be giving away free tattoos were asked two follow-up questions.  First, when asked when they made their decision to get a tattoo that night before or after arriving at the party, 85% said they made their decision before arrival and 15% made the decision after arriving.  When further asked, on a scale of 0-100, how likely did they think they were to get a tattoo that night, people were on average 65% sure they would be getting a tattoo.

As the research assistant was collecting the data, another tattoo artist (not the one that work working that evening, but a competitor) stopped by to tell give us her opinion about the free tattoo practice. This petite brunette, with a medallion tattoo on her lower sternum, felt it was her responsibility to tell us in gory detail about all the unhygienic and potentially health hazardous practices she had witnessed throughout the evening. She talked about how a contaminated paper towel had been passed around and how an obvious necessity missing from the set-up was any sort of disinfectant. She said all these practices could cause these people to contract a blood disease like Hepatitis, HIV, etc. Whether her concerns were valid or not, it became clear to us that the real cost of tattoos are not their price, but the odds for infections and long-term illness.

You decide:

The results indicate that the power of “free” is surprisingly influential.  When we face a decision about a tattoo, one would hope that the long term permanency of the decision, coupled with the risks of getting different types of infections would cause people to pay little attention to price, and certainly not to be swayed one way or another by the power of free.  But sadly, the reality (at list in the nightclub scene in New York) suggests that the power of free can get us to make many foolish decisions.  So next time, when you are facing a decision about a “free” offer, my suggestion would be to imagine what you would do if the price was not free and instead it was very cheap (maybe $1) — and ask yourself if this would change your behavior.  And if you would make a different decision if free was not involved, maybe this is a good sigh that the decision was not that good to start with?

A few years ago, a marketing team from a major consumer goods company came to my lab eager to test some new pricing mechanisms using principles of behavioral economics. We decided to start by testing the allure of “free,” a subject my students and I had been studying. I was excited: The company would gain insights into its customers’ decision making, and we’d get useful data for our academic work. The team agreed to create multiple websites with different offers and pricing and then observe how each worked out in terms of appeal, orders, and revenue.

Several months later, right before we were due to go live, we had a meeting about the final details of the experiment—this time with a bigger entourage from marketing. One of the new members noted that because we were extending differing offers, some customers might buy a product that was not ideal for them, spend too much money, or get a worse deal overall than others. He was correct, of course. In any experiment, someone gets the short end of the stick. Take clinical medical trials, I said to the team. When testing chemotherapy treatments, some patients suffer more so that, down the road, others might suffer less. I hoped this put it in perspective. Fortunately, I said, price testing household products requires far less suffering than chemo trials.

But I could tell I was losing them. In a sense, I was impressed. It was a beautiful human sentiment they were conveying: We care about all customers and don’t want to treat any one of them unfairly. A debate ensued among the group: Are we willing to sacrifice some customers “just” to learn how the new pricing approaches work?

They hedged. They asked me what I thought the best approach was. I told them that I was willing to share my intuition but that intuition is a remarkably bad thing to rely on. Only an experiment gives you the evidence you need. In the end, it wasn’t enough to convince them, and they called off the project.

This is a typical case, I’ve found. I’ve often tried to help companies do experiments, and usually I fail spectacularly. I remember one company that was having trouble getting its bonuses right. I suggested they do some experiments, or at least a survey. The HR staff said no, it was a miserable time in the company. Everyone was unhappy, and management didn’t want to add to the trouble by messing with people’s bonuses merely for the sake of learning. But the employees are already unhappy, I thought, and the experiments would have provided evidence for how to make them less so in the years to come. How is that a bad idea?

Companies pay amazing amounts of money to get answers from consultants with overdeveloped confidence in their own intuition. Managers rely on focus groups—a dozen people riffing on something they know little about—to set strategies. And yet, companies won’t experiment to find evidence of the right way forward.

I think this irrational behavior stems from two sources. One is the nature of experiments themselves. As the people at the consumer goods firm pointed out, experiments require short-term losses for long-term gains. Companies (and people) are notoriously bad at making those trade-offs. Second, there’s the false sense of security that heeding experts provides. When we pay consultants, we get an answer from them and not a list of experiments to conduct. We tend to value answers over questions because answers allow us to take action, while questions mean that we need to keep thinking. Never mind that asking good questions and gathering evidence usually guides us to better answers.

Despite the fact that it goes against how business works, experimentation is making headway at some companies. Scott Cook, the founder of Intuit, tells me he’s trying to create a culture of experimentation in which failing is perfectly fine. Whatever happens, he tells his staff, you’re doing right because you’ve created evidence, which is better than anyone’s intuition. He says the organization is buzzing with experiments.

And so is that consumer goods company. A group there is studying consumer psychology and behavioral economics and is amassing evidence that’s impressive by any academic standard. Years after our false start, they’re recognizing the dangers of relying on intuition.

This first appeared at HBR

The New York Times and Time Magazine have recently posted interesting articles about two new books that discuss consumer behavior: Chris Anderson’s Free and Ellen Ruppel Shell’s Cheap (see links in The New York Times and Time Magazine).

Both books reference our Hershey’s Kiss experiment that is described in Chapter 3 of Predictably Irrational. If you recall, in one trial of one study we offered students a Lindt Truffle for 26 cents and a Hershey’s Kiss for 1 cent and observed the buying behavior: 40 percent went with the truffle and 40 percent with the Kiss. When we dropped the price of both chocolates by just 1 cent, we observed that suddenly 90 percent of participants opted for the free Kiss, even though the relative price between the two was the same. We concluded that FREE! is indeed a very powerful force.

It’s important to note that we have carried out lots and lots of studies on the effect of FREE!, many of which are detailed in Predictably Irrational. Describing them all, however, would be too much for those who are trying to make just one point abut this effect, so naturally we see authors making choices about which experiments to describe and which ones to leave in footnotes, or not to mention at all. But, some  kinds of omissions are made as well — ones that are important for understanding the complexity of the effect.

For example, in one study of FREE!, we tried lowering the price from 2 cents to one cent on the Kiss to see if we observed that same level of increase in demand in the Kiss. We didn’t. In another study we also tried seeing what would happen if we lowered the price from FREE! to negative one cent, and we also didn’t see a difference in behavior. We also tried the experiment on a broad demographic–not just college students, but also on children and older adults.
Personally, I think it is perfectly fine for people to take the main point from some experiments and build on it, but as readers (and writers) we should realize that often there is more complexity to the picture and that before criticizing particular findings, or citing them as supporting evidence, we should keep in mind the nuances.

Someone should remind Michael Bloomberg that free does not always mean free lunches.

The billionaire New York City mayor recently rolled out a transit proposal that sounds too good to be true – probably because it is.

In order to speed up the pace of Manhattan’s famously slow crosstown buses, mayor Bloomberg suggested eliminating the $2.25 fare on a few of the buses, as it would put an end to all the time passengers spend fumbling for their MetroCard and cash at the bus door. It would mean free bus rides for all, but without much additional cost to the city, he reasoned, since the majority of crosstown passengers are already riding for free, using their MetroCards to transfer from the subway. If we aren’t charging folks anyway, it’s not a big money loss, is the gist of his claim.

In short: win-win.

Except, there’s a flaw to his argument.  If bus fare falls to zero, it’s likely that more people (many more people) will start riding the bus, which will lead to even worse congestion and potentially require the city to spend on introducing more buses.

In other words, mayor Bloomberg is harboring under the assumption that demand for the cross town bus will not change as the price drops. In all likelihood, however, the number of bus-riders will go up dramatically because free is exciting. In fact, according to our research on free, such a change will cause many people who now walk a few blocks, to switch their ways and hop on the free bus.

A few people purchased the original version of Predictably Irrational since it came out in February 2008.

Now that the expanded edition is out, it seemed to me that the right thing would be to get the extra material to those who have purchased the book already.  After discussing this idea with HarperCollins, my publisher, we decided to try an honor system for distributing the extra material.

So — if you purchased the original version of Predictably Irrational and you want the extra material, please email  piexpanded@gmail.com and we will email you back the added information in 3 PDFs (a new introduction, added material about the original chapters, and reflections about the financial markets).

Irrationally yours

Dan

What if on your next coffee run, you discover that Starbucks has started running on the honor system? All the baristas are gone, and in their place, you find Tupperware filled with coins and bills. Would you pay for your daily soy Latte? Or would you “forget” to shell out the five bucks? Be honest.

This, of course, is only a thought experiment, as I doubt Starbucks will be adopting the honor policy anytime soon. But in another part of the world, it’s a real question that residents are facing on a daily basis. As the New York Times recently reported, the attorney general’s office in Indonesia has been opening thousands of “honesty cafes” as part of its anticorruption campaign.

The idea is that these cashier-free cafes will teach people to be honest and curb the country’s corruption problem (which pervades business, politics, and education) by inducing residents – especially the young – to get into the habit of practicing honesty. As the Times reports, “…the cafes are meant to force people to think constantly about whether they are being honest and, presumably, make them feel guilty if they are not.”

It’s a laudable plan, and a lovely feel-good idea, but will it work? I have my doubts.

First I think that people will also cheat to a certain extent in these honesty cafes (as they do in our experiments). In fact, according to one Indonesian student, they already do: “Some of my friends don’t pay the right amount.”

But that’s not the worst of it. I worry that these cafes won’t just fail to discourage cheating – they will actually lead to more of it. In some of our research, we found that cheating on one occasion makes it easier for people to cheat again on a later task, because it alters their self-concept. (Think of dieting as an analogy: once you break your diet once, it’s that much easier to say, “Oh what the hey, cut me a slice of that chocolate cake; I’ll count calories again tomorrow.”)

With honesty cafés widespread, residents will have more temptations to cheat, more occasion to cheat, and maybe this will make it such that they will find it easier to cheat again in other contexts.

Maybe these cafes are a good idea, maybe it will not have any effect, but I worry that it might make things worse.